How do I start saving for retirement?
Open a 401(k) through your employer.
If you’re employed full-time by someone else, you may have the option of saving for retirement using a 401(k). Your employer may encourage you to sign up by offering to match whatever you contribute up to a certain percentage of your gross income. That’s free money on the table and therefore a guaranteed return, so always take advantage of an employer match if it’s an option. (Employers are not required to offer matching contributions, but it’s still a good idea to participate if they don’t.)
Let’s say your employer matches up to 5 percent. If you earn $45,000 a year and put 5 percent of your salary ($2,250) into your 401(k), you’d get the full employer match. That means you’ll get an extra $2,250 toward your retirement, which will earn compound interest over time. Plus, your contribution is deducted from your paycheck before any taxes are withheld, which lowers your taxable gross income. That means you’ll pay lower taxes too.
Once you set up your 401(k), money will often be auto-deducted from your paychecks and deposited in your brokerage account. Although your employer chooses which financial firm provides its 401(k) services, you decide the mix of stocks, bonds, or other investments you’d like to make. After the initial setup, it’s one less mental to-do each month, and you can log in once or twice a year to check your balances. If you’re stressed about what to pick, you can start simple with a target-date mutual fund tied to the approximate year you plan to retire, which is risk balanced accordingly. Then, as you gain confidence as an investor, you can tweak and rebuild your portfolio to match your goals and risk tolerance.
Before you opt in to a company’s matching program, make sure you understand its vesting schedule, which determines when the money it contributes to your 401(k) actually becomes yours. There are three main types of vesting schedules:
- Immediate: Any money your employer uses to match is fully vested right away and yours to keep whenever you leave the company.
- Graded: You get to keep a percentage of the employer match each year, say 20 percent in year one, 40 percent in year two, and so on until it’s 100 percent vested. If you left after year one, you’d only get to keep 20 percent of your employer’s contributions.
- Cliff: You get nothing until you are fully vested, often around five years of employment.
Remember: You always get to keep the money that you contribute. Vesting is just about the employer match.
Open an IRA account on your own.
You can opt to use an Individual Retirement Arrangement, or IRA, in addition to your 401(k) or on its own if retirement benefits are not available to you at your current job. An IRA comes in two forms: Roth or Traditional.
- Traditional: You get the tax advantage today by contributing pre-tax—the money you put in the account is subtracted from your taxable income for the year, and you only pay taxes once you start withdrawing from the account in your retirement.
- Roth: You can take your money out tax-free in retirement, because you fund it with post-tax dollars.
It’s often said that a Roth IRA better suits younger workers, because your tax bracket now is probably lower than it will be in the future and you’re paying taxes on today’s dollars—but honestly, either way, you’re preparing for retirement, which is a big win!
Smart Tip: In 2020, you may contribute up to $6,000 to a Traditional or Roth IRA. The maximum annual 401(k) contribution is $19,500 (for anyone under age 50).